What are the top considerations for liquidation preference negotiations in Australia? February 9, 2022

Liquidation preference negotiations require careful planning and expert guidance

Attracting investors is a significant part of the Australian corporate landscape, especially for start-ups or fast growing companies. Investors in these companies will often require a form of ‘liquidation preference’ as a condition of their investment.  Find out about our top considerations for liquidation preference negotiations in Australia. 

What are liquidation preferences?

A liquidation preference is a special right attaching to a share. 

Where there’s a liquidation event, liquidation preferences protect investors by ensuring they get their investments back before other shareholders. In other words, they give investors priority over other shareholders. 

Liquidation events can include:

• Liquidation
• Bankruptcy
• The sale of all or substantially all of the company’s assets

Suppose the liquidation event is the sale of all of the company’s assets. In that case, the investors with a liquidation preference are the first shareholders in line for a share of the profits from that sale. 

After liquidation preferences are paid, payout priorities are given to all shareholders.  This may even include the investors with the liquidation preference, depending on whether their preference right is participating or non- participating. 

How do liquidation preferences work?

In Australia, there are two main types of liquidation preference: participating and non-participating. It’s important to understand the difference between the two, so you can work out whether the preference on offer will suit your situation. 

Participating liquidation preferences

A participating liquidation preference gives the investor priority over a guaranteed sum.  They then have the right to share in the pool of any remaining funds proportionate to their shareholding. 

Typically, when acting for company founders, we prefer not to grant these types of preferences. 

Non-participating liquidation preferences

Non-participating liquidation preferences give the investor priority over a guaranteed sum. However, it differs from participating liquidation preferences in the way it deals with any remaining funds. Non-participating liquidation preferences don’t provide the investor the right to share in the proceeds of the liquidation event once they have received their guaranteed sum (usually the amount they originally invested).  

One option that we often see is an investor having the right to convert their preference shares into ordinary shares prior to the liquidation event, in which case their shares would be treated the same as any other shareholder. An investor would chose to convert in circumstances where the value of their percentage entitlement to the proceeds from the liquidation event is greater than the amount they originally invested (assuming a 1x preference).

The final word

Understanding liquidation preferences and how they impact your company is a critical step in protecting the value of your holding in the company. 

Contact us for expert advice about liquidation preference negotiations in Australia.